Environmental update

Changes in government regulations dealing with pollution and other forms of environmental degradation are creating new opportunities and burdens for commercial real estate. Concerns over issues ranging from building on contaminated land to water conservation are increasing the demand for various kinds of environmental services tailored to real estate.

"The Environmental Protection Agency and other federal regulators are moving in the right direction," says Michael Logsdon, president of EMG Inc., an environmental services firm based in Hunt Valley, Md. EMG is representative of a growing number of companies that specialize in providing environmental due diligence services for real estate transactions.

Perhaps the most significant change is an EPA plan to remove regulatory barriers to new development on land considered contaminated. Other new regulations involving such agencies as the Occupational Safety and Health Administration are expected to lead to stricter standards for indoor air quality, dust from lead paint and asbestos particles.

The EPA is in the process of developing guidelines for clean-up and redevelopment of sites with environmental contamination. Through economic development the EPA hopes to mitigate environmental problems and halt the downward spiral of the value of sites with soil and/or water pollution problems.

The objective of a new EPA pilot program known as the Brownfields Economic Redevelopment Initiative is to encourage local governments to establish or augment voluntary clean-up combined with redevelopment projects. "Economic development and environmental protection must go hand-in-hand," according to the EPA.

"Brownfields are abandoned, idled or under-used industrial and commercial facilities where expansion or redevelopment is complicated by real or perceived environmental contamination," as the EPA defines them.

The EPA plans to provide $200,000 in seed money to local governments during the next two years to help devise remediation strategies and guidelines to alleviate liability concerns, which presently discourage investors, developers and lenders from getting involved with projects on contaminated sites. Commitments from the EPA not to pursue enforcement of environmental regulations in specific situations are expected to be included in yet-to-be-determined guidelines.

Eighteen sites already have been selected by the EPA, whereby contaminated land is being reclassified as "brownfields" for the purpose of removing regulatory and economic barriers to new construction. The EPA plans to select a total of 50 sites before the end of 1996.

Most of the sites designated for the Brownfields Initiative are located east of the Mississippi in Baltimore, Cleveland, Detroit, Indianapolis, Knoxville, Louisville, Trenton and in Illinois--a region known as the West Central Municipal Conference. Other cities already selected with sites include: New Orleans, Birmingham, Ala.; Bridgeport, Conn.; Richmond, Va.; Rochester, N.Y.; and the Cape Charles Northampton County area of Virginia. Further west the EPA has designated sites for the program in: St. Louis; Laredo, Texas; Sacramento, Calif.; and several municipalities in the vicinity of Astoria, Ore., collectively known locally as the Oregon Mill Sites.

The Brownfields Initiative represents progress, according to Logsdon, because the EPA is beginning to take into account the economic impact of its regulations. He says existing regulations do little more than encourage litigation, but Logsdon is optimistic that the Brownfields Initiative will serve as an incentive to clean up environmental contamination. "It will likely help eliminate taboos associated with hazardous waste sites and adjacent parcels, which often leads lenders to shy away from financing projects on such sites."

"Balancing economic and environmental concerns is long overdue," says Tim Tosta, a partner in the San Francisco office of the real estate law firm Baker McKenzie, which often must deal with environmental issues when working to obtain permits and approvals for new development. Environmental regulation is mired in litigation and studies, which drives up costs and usually leads to little being done to resolve problems, Tosta says.

"There are instances where parties go bankrupt or die before anything is resolved and many times land is donated to groups that don't intend to use it, so there will be no potential litigation in the future," he adds. "There are no economic incentives for clean-ups and the whole system needs to be re-examined."

Water conservation is the only area with a clear-cut economic incentive for real estate owners to make decisions that benefit the environment. An Orlando-based company called Enviro-Check Inc. is using new telecommunications technology to pass along water usage costs to apartment dwellers. It installs meters and modems to submeter water consumption and bill tenants for owners of large multifamily housing complexes.

Submetering typically reduces water, bills 16 percent to 24 percent and owners are reimbursed for water used by tenants. Chuck Wright, vice president of marketing at Enviro-Check, says water bills in some regions of the United States are rising faster than other utility costs and water will eventually cost more than electricity in some regions.

The real estate industry is facing mounting pressure from lenders to sign environmental indemnities to obtain real estate financing, but few lenders are requiring borrowers to obtain environmental insurance; Phase One Environmental Assessment Reports have virtually become mandatory requirements to get loans.

"During the credit crunch and subsequent foreclosures and disposition of REOs, many lenders were forced to pay for clean-up of environmental contamination, so they,re careful to avoid getting burned again," says Brad May, national accounts director of ATEC Environmental Associates Inc., an environmental consulting firm based in Indianapolis.

Since the mid-1980s, Deerfield, Ill.based Eckland Consultants Inc. (ECI) has provided Phase One environmental assessment services. According to marketing director Frank Hennessey, the environmental consulting firm includes four major components in its assessments: Records Review (federal, state and local), Site Reconnaissance, Interviews and Reporting. Should an ECI client require other specifications for performance of Phase One reports, ECI will customize the project elements to meet that client's individual needs, Hennessey says. The Phase One report may then include such tests as asbestos, lead in water, lead-based paint or radon.

According to John Luna, vice president of marketing at Building Analytics, an environmental engineering firm based in Glendale, Calif., "Lenders want to feel warm and fuzzy that they won't get stuck with environmental problems. So they are beginning to require environmental insurance."

Costs for Phase One reports vary greatly depending on the services performed, but everyone agrees that increased competition is driving costs down. "The most important thing to remember is that many providers of environmental services will promote conducting studies and monitoring problems to generate cashflows, rather than actually recommending taking specific actions to correct problems," warns Luna. "Some companies have made a fine art of conducting studies," he says.

Luna recommends that property owners develop databases to track properties, updating environmental reports on an annual basis to detect potential problems and protect themselves from possible legal liabilities. "It can be a resource when dealing with lenders and an efficient way to monitor how tenants use chemicals and conduct processes that could lead to problems if done improperly," he says.

The most critical environmental problem presently facing the real estate industry is soil and ground water contamination, environmental specialists agree. Tosta believes, however, that the federal Endangered Species Act will be more troublesome for developers in the future than environmental contamination caused by leaking underground storage tanks.

We can expect fewer problems with underground storage tanks in the future because tanks currently considered to be in poor condition are being removed and the existing regulations will help prevent potential problems. "I think the clean-up issue with underground tanks will eventually go away because new problems aren't being created," Tosta says.

The biggest flaw in environmental regulation is a failure to establish standards and priorities for clean-up based on the intended use of contaminated sites, Tosta continues. He believes that clean-up goals should take into account whether the sites are intended for future industrial use versus building a school or office building.

"Environmental values have been placed at a moral high point, but the environment should not always be paramount at all costs. The present notion of keeping everything equally clean is nuts," Tosta opines.

"The Endangered Species Act is regulatory overkill," he says, "because it fails to weigh economic benefits against the value of preserving habitat for a particular species." Tosta believes it is foolish to protect endangered species without considering the economic impact on humans.

According to Tosta, consideration should be given to the benefits of development in a revision of the Endangered Species Act, which is presently skewed against development, without taking into account that people need places to live and work. "The desire to protect everything has gotten ahead of development. Nobody is making hard choices or putting things in relative pecking orders.

"A better regulatory policy would consider all the costs and benefits of development versus protecting an endangered species, rather than using regulations to automatically favor protection of endangered species," Tosta continues. Taking into account the economic benefits of development would provide much-needed balance in the Endangered Species Act, but this does not require dismantling or eliminating all protections for endangered species, he says.

Other environmental concerns such as lead paint, asbestos and indoor air quality are perceived as being easier to manage as well as less costly to resolve. Years of experience in dealing with lead paint and asbestos have made handling these matters more of a regulatory compliance issue for building maintenance rather than a major environmental concern. For the time being, unless lead paint is peeling or flaking, the experts say it is unlikely to cause a problem, regulatory or otherwise. Although not everyone agrees with this opinion, the method of treatment will probably remain the same until state regulators enact new regulations.

The present strategy of covering up lead paint with other coatings does not address the problem, says Luna, and the real estate industry can expect this issue will eventually be revisited, with stringent regulations being imposed at some point in the future.

Lead paint will likely become a more troublesome issue as litigation follows enactment of new state environmental regulations. "I certainly believe the legal liabilities aspects have yet to be seen," says John R. Gallagher, 1996 president of the Institute of Real Estate Management. "Lead paint becomes a problem when it's being removed," says Gallagher, "because the dust that will be created in the removal process is more dangerous than encapsulating it under another surface coating."

Asbestos contamination is no longer considered a major issue because the majority of the affected areas have been abated by now. "Asbestos has become easier to deal with because regulations on the books spell out what actions to take," Gallagher says.

"New OSHA regulations implemented Oct. 1, 1995 now require building owners to substantiate that buildings do not have asbestos problems, which shouldn't be difficult," Gallagher says. "All that's needed to comply is an environmental engineering report, but there is little chance of asbestos problems being found because the substance hasn't been used in new construction since 1972," he adds.

If any questions arise concerning older buildings, the easiest and most economical way to determine how to deal with asbestos is to review information readily available on recorded videocassette tapes. "There are plenty of environmental engineers showing video demonstrations and jars with asbestos samples," says Gallagher.

New environmental concerns arising dealing with indoor air quality are expected to lead to new EPA and OSHA regulations and standards. Such regulations are expected to include providing a specified amount of humidity and airflow, measured in cubic meters. "This is something that is imminent and will be adopted, but details of the regulations haven't yet been decided," Gallagher says.

Within five years, companies will need to monitor indoor air quality as part of routine environmental inspections, predicts Irene Bledel, president of Environmental Resource Management Process Management, a new indoor air quality consulting firm based in Atlanta. The firm provides services to companies being sued by people claiming their health is being adversely affected by indoor air quality problems.

Problems caused by emissions from office machines such as photocopiers and printers-particularly inside buildings without windows that open--are being exacerbated by companies trying to reduce overhead expenses by crowding more people into offices and cutting back on ventilation. "The biggest contributing factor to unhealthy buildings with poor air quality in the workplace comes from corporate directives to cut maintenance and overhead costs," Bledel says.

A few years ago it used to be common to provide 200 sq. ft. of space per person in a building, but due to corporate downsizing that amount of space is shrunk to 150 sq. ft. or less, according to Bledel. Buildings are being overloaded with more people than ventilation systems are designed to serve, she says.

Indoor air pollution problems pose a greater environmental health risk than outdoor air pollution and hazardous wastes, according to the Science Advisory Board of the EPA. Solutions to air quality problems generally require creating areas of negative air pressure with vents to allow fumes to escape outside, while also making sure that adequate supplies of fresh air are flowing through buildings, Bledel says.

Indoor air quality also is affected by the fungus and mold prevalent in ventilation systems. Though common, none of these problems is well-publicized due to the fact that most lawsuits are settled out-of-court, with records sealed as part of the settlement agreement. Bledel says that the average out-of-court settlement ranges between $130,000 to $250,000. "That doesn't include legal fees and the cost of absenteeism that poor air quality problems create," she says.

According to Gallagher, the biggest problem with any environmental regulation is often the level of documentation required by regulatory bodies. Such levels impose a disproportionate amount of responsibility on small property owners, who are unable to negotiate discounts for services like larger Fortune 500 companies.

"Problems like contamination from leaky underground storage tanks and concerns about indoor air quality are going to be resolved, but the record-keeping requirements and documentation of compliance will never go away," Gallagher says.